What are the Tax Implications of Assuming a Mortgage?

When you’re considering buying a home, one option might be to assume the seller’s mortgage instead of obtaining a new loan. But what does that mean for you, especially when it comes to taxes?

This post provides expert insights into the tax implications of assuming a mortgage. We’ll also break down the concept of mortgage assumption, clarify what loan types might qualify, and provide tips about this growing homeownership trend.

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Disclaimer: This post is for educational purposes and is not intended to be construed as tax advice. HomeLight always encourages you to reach out to an advisor.

What does it mean to assume a mortgage?

Assuming a mortgage means that you take over the existing mortgage from the current homeowner rather than securing a new loan. When you assume a mortgage, you agree to adopt the interest rate, remaining balance, and repayment period of the original loan. This can be an attractive option if the existing loan terms are favorable compared to current market rates.

Are all mortgage loans assumable?

Not all mortgage loans are assumable. The ability to assume a mortgage depends on the lender and the type of loan. Here are some examples of mortgage loans that are assumable:

• FHA loans: These mortgage loans are backed by the Federal Housing Administration (FHA). They are a popular choice for many buyers because of their flexible eligibility criteria and relatively lower down payment requirements.
• VA loans: Loans backed by the Department of Veterans Affairs (VA) are generally considered assumable. You don’t necessarily need to be a veteran to assume a VA loan, but the least complicated transfer and approval can happen if another qualified military buyer assumes the mortgage.
• USDA loans: USDA loans are similar to FHA and VA loans but are usually more popular with rural homebuyers. They are also assumable with approval from the USDA, and you must meet their eligibility criteria.
• Conventional loans: Conventional loans are less likely to be assumable. Most conventional loans have what’s known as a “due on sale” clause that requires the loan to be paid in full if the property is sold or transferred. However, there are exceptions,  such as older loans or assumptions after a death or divorce.
• Adjustable-rate mortgages (ARMs): Some ARMs are assumable, but this is an uncommon option because of their complexities. It depends on the lender and the specific terms of the mortgage.

Other loans, such as jumbo mortgages, may also be assumable. It’s crucial to check with the lender in advance to understand if a loan is assumable and any requirements you must meet.

What’s the process to assume a mortgage?

The process of assuming a mortgage involves several key steps:

• Eligibility check: First, you need to determine if the existing mortgage is assumable. You can find this information in the original mortgage agreement or by contacting the lender.
• Credit review: The lender will then review your credit history and financial stability to ensure you can take over the payments.
• Agreement: If you meet the lender’s criteria, you’ll proceed with an assumption agreement, which transfers the mortgage responsibilities from the original borrower to you. This step also involves getting a proper release of responsibility for the seller.
• Closing: Similar to a traditional mortgage process, assuming a mortgage requires a closing, where legal documents are signed and the transfer is officially recorded.

What are the tax implications of assuming a mortgage?

Assuming a mortgage carries the same tax implications that you might expect when buying a home with a new loan. To provide expert insights, we spoke to Nicole Green, a senior tax consultant with Robert Hall & Associates who has nearly 10 years of experience.

Contrary to what some people might hope, assuming a mortgage does not mean that you will avoid paying taxes on the property.

Tax basis of the home

Green starts by setting the record straight about the assumed-mortgage home’s basis, the amount the property is worth for tax purposes. The IRS defines “basis” this way: “Your adjusted basis is generally your cost in acquiring your home plus the cost of any capital improvements you made, less casualty loss amounts and other decreases.”

“For the buyers — the ones assuming the loan — this works like any other purchase regardless of how much the loan is or if they need to assume one and get a second loan,” Green explains. “We treat it as any other home purchase. If you purchase a home for $1 million and assume a mortgage of $800,000, your basis in the house is still $1 million. The only difference is that because it is not a new loan, if you pay points, they will be amortized.”

»Learn more: What Documents Will I Need for Taxes if I Bought a House?

Gift tax implications

Mortgage assumptions are common within families. Green says that if you are assuming a mortgage loan from a family member selling you a house below the estimated market value, the difference in price to value can be considered a gift for tax purposes. This may have implications for what’s known as a gift tax, which could affect your family member’s annual gift tax exclusion.

»Learn more: Can I Sell My House to a Family Member at Below Market Value?

Property tax reassessment

Transferring property ownership can trigger a reassessment of the property tax, potentially increasing your tax liability. As you plan the assumption, you’ll want to research the potential property tax ramifications. Here again, if you are assuming a loan from a family member, you should also check state tax rules. Some states, like California, have limited the parent-child tax exclusions.

»Learn more: Property Value Assessment: A Guide for Homebuyers

Mortgage interest deduction

As with any home purchase, if you itemize deductions when preparing your taxes, you may be able to deduct mortgage interest. However, this depends on the loan amount, the property’s purchase price, and how long you held the assumed loan during the tax year.

»Learn more: Claiming the Mortgage Interest Tax Deduction

Impact on taxes for the seller

According to Green, “There is no difference tax-wise for the seller when their mortgage is assumed.” This simplicity can make assuming a mortgage an attractive option for sellers looking to transfer property without altering their tax circumstances.

The exception is the possibility of a gift tax, as noted above. The IRS explains that this tax is on the “transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax applies whether or not the donor intends the transfer to be a gift.” The donor is generally responsible for paying the gift tax.

»Learn more: Tax Implications of Selling a Home

Capital gains tax considerations for future sale

Whether you use a new loan or assume an existing loan to purchase the home, when you eventually sell the property, you will still be subject to capital gains tax rules on any profits you make.

“It doesn’t change the capital gains tax,” Green says. “Going back to the first example, if you purchase a home for $1 million, and assume a loan for $800,000, and then you sell it for $1.2 million, you will need to pay capital gains tax on $200,000 profit.”

In other words, the original purchase price versus the sale price determines the gain, irrespective of any assumed mortgage.

Of course, capital gains on the sale of a primary residence are subject to tax exemptions or exclusions, depending on your jurisdiction and circumstances, such as how long you lived in the home. If you qualify, you can exclude up to $250,000 of gain from your income, or up to $500,000 of gain if you file a joint return with your spouse.

»Learn more: 6 Ways to Avoid Paying Capital Gains Tax on Your Home Sale

Mortgage assumption is still considered a purchase

“In general, loans are not really a big part of taxes,” Green says. “People think, ‘Oh, I sold my house for $600,000 but paid off the loan for $400,000, so I only have a profit of $200,000.’ No! That is not how you calculate that. No one cares about the loan. If you get a loan for something, it is still a purchase. So, assuming a mortgage doesn’t really affect things much.”

»Learn more: A Guide to Assumable Mortgages in Today’s Market